Role of state in the macroeconomy Flashcards
What is public expenditure?
Represents a significant portion of aggregate demand (AD) in many economies
What are the 3 categories of public expenditure?
- Current expenditures - Daily payments required to run government and public sector (salaries)
- Capital expenditures - Investment in infrastructure and capital equipment (building)
- Transfer payments - Payments made by the government for which no goods/services exchanged. Does not contribute to GDP
How is changing incomes a reason for changing size and composition of public expenditure?
- Countries with low income = low tax revenue = low government expenditure
- As incomes increase, citizens demand a higher quantity and quality of services
How is changing age distribution a reason for changing size and composition of public expenditure?
- Many developed countries have lower birth rates creating a situation where there is a growing ageing population
- Life expectancy has increased due to medicine and nutrition
- Gov spending on pension payments and healthcare will increase to support elderly population
How is changing expectations a reason for changing size and composition of public expenditure?
- As societal norms change, expectations change and this puts pressure on governments to change the substance and delivery mechanism
- Increased spending
How is The Global Financial Crisis of 2008 a reason for changing size and composition of public expenditure?
- UK government borrowing increased significantly in order to facilitate the government spending required to avoid long lasting depression
- This borrowing had to be repaid with interest in the years following the crisis, UK had to cut their expenditure and raised tax revenues
What are the advantages of public expenditure?
- Improvements to supply side of economy through expenditure on infrastructure, health and education
- Improve equality of opportunity e.g education for all children
- Raises standards of living
- Reduces poverty and increases equality
- Drives innovation
What are the disadvantages of public expenditure?
- Urgency of labour diminishes and resources are used more inefficiently
- Opportunities for corruption which can decrease standard of living
- Worsening budget deficit
- Crowding out
- Increasing taxation levels
What is a progressive taxation system?
As income rises, a larger % of income is paid in tax
What is a regressive tax system?
As income rises, s smaller % of income is paid in tax
What is a proportional tax system?
The % of income paid in tax is constant, not matter what level of income
How is the incentive to work an effect of changes in tax rates?
- Higher tax rates = lower incentive to seek work or to work overtime
How is tax revenue an effect of changes in tax rates?
- The Laffer curve illustrates the relationship between increasing tax rates and level of government revenue received
- As tax rates increase, a point will be reached where disincentivised workers work less resulting in less income and less government tax revenue
How is the income distribution an effect of changes in tax rates?
- A progressive tax system redistributes from those with higher income to those with lower incomes
How is the real output and employment an effect of changes in tax rates?
- If tax rates increase, more money is withdrawn from circular inflow of income
- Less disposable income
- Unemployment may rise
How is average price level an effect of changes in tax rates?
- Increase in direct taxes reduces disposable income and so workers may petition their employer for a salary increase
- Increase cost of production may lead cost push inflation
How is the trade balance an effect of changes in tax rates?
- Increase in taxes can reduce disposable income which is likely to reduce imports
- May improve trade balance
How is FDI an effect of changes in tax rates?
- Rate of corporation tax increases relative to other countries, may result in less FDI
What is an automatic stabiliser?
Automatic fiscal changes as the economy moves through stages of the business/trade cycle
What is a discretionary fiscal policy? Expansionary and contractionary?
A demand side policy that uses government spending and taxation to influence AD
Expansion - increases AD (cut in taxes and increase in G)
Contractionary - decreases AD (increase in taxes and cut in G, used to reduce inflation and gov deficit)
What is the difference between cyclical deficits and structural deficits, and their causes?
Cyclical = Occur due to downturns in business/trade cycle, usually as a result of a recession and is caused by automatic stabilisers in action (less tax revenue and gov spending increases)
Structural = Present even when an economy may be operating at the full employment level of output like a boom and cyclical deficit is 0 (difficult to correct, caused by tax avoidance culture, ageing population, lack of productivity or spending decisions)
How does the state of the economy influence the size of fiscal deficits?
Government revenue often increases in a boom and decreases during a recession
Government spending often decreases in a boom and increases in a recession
Fiscal deficits tend to increase as the state of the economy worsens
How does the housing market influence the size of fiscal deficits?
Government receives indirect tax from property sales, revenue increases when economy is doing well and reduces fiscal deficits
How do political priorities influence the size of fiscal deficits?
- If priorities change, fiscal deficit may change
- UK gov spent billions in rescuing the economy after the Global Financial Crisis of 2008
